The Unequal Economic Consequences of Carbon Pricing

This paper studies how carbon pricing affects emissions, economic aggregates and inequality. Exploiting institutional features of the European carbon market and high-frequency data, I identify a carbon policy shock. I find that a tighter carbon pricing regime leads to a significant increase in energy prices, a persistent fall in emissions and an uptick in green innovation. This comes at the cost of a temporary fall in economic activity, which is not borne equally across society: poorer households lower their consumption significantly while richer households are less affected. Not only are the poor more exposed because of their higher energy share, they also experience a larger fall in their income. These indirect effects account for over 80 percent of the aggregate effect on consumption. A climate-economy model with heterogeneity in households' energy shares, income incidence and marginal propensities to consume is able to account for these facts